Unexpectedly for many, [the emerging world]—with China leading the way—became a robust locomotive for a global economy that was still structurally impaired by the overleveraged advanced economies.
—Mohamed A. El-Erian, The Only Game in Town (2016)
China today is a Rorschach test of American leadership. How we respond to its murky mass of conflicting images—great cities of mostly empty skyscrapers next to industrial zones churning with much of the world’s manufacturing capacity, military charades and cyberwar aggressions accompanied by monetary statesmanship and wild prodigality, miracles of growth and swamps of pollution, alleged harvesting of body parts from Falun Gong prisoners and a robust Christian population of between 67 and 130 million, capitalist chaos and communist brutality—will likely determine the American future.
Each of these images contains an important element of truth. But leadership entails selection, prioritization, and strategic insight. Trying to respond to all the images at once will produce not a coherent or sophisticated policy but a stream of spastic reflexes, as we have seen in the Obama administration. It blandishes the Chinese for silly and insincere commitments to carbon dioxide abatement one day and the next dispatches warships to the Spratly Islands to discourage land reclamation projects on reefs in the South China Sea. Denunciations of the Chinese for trumped-up charges of currency “manipulation” are followed by obsequious entreaties to participate in expanded Pacific trade or climate change treaties.
Silly tough-guy postures and blind monotheories can be found on the Right as well. Does the incendiary sage David Stockman, President Reagan’s budget director, really mean it when he describes the country as “the Great China Ponzi” or as “an entire nation of 1.3 billion . . . gone mad building, borrowing, speculating, scheming, cheating, lying and stealing”?1
And what does Donald Trump have in mind when he bellows, “You have to do something to rein in China. They’re making it absolutely impossible for the U.S. to compete”? He cites as a devastating instrument of unfair trade a yuan devaluation of 3 to 4 percent. As the economist John Mauldin points out, “The simple fact is that [before this recent minor devaluation] the Chinese currency rose by 20 percent over the last five years.” Measured by the vigor of intervention, he says, “the Federal Reserve has been the most egregious currency manipulator in the world” during this same period. “Trump and all those who prattle on about Chinese currency manipulation have the economic comprehension of a parakeet.”
Stockman’s charge is more interesting because it is based on an array of astonishing figures. It is indeed stunning that China produced ten times more steel over the last twenty years than did the United States and Japan together and “used more cement in the last three years than the U.S. used in the entire twentieth century.” His case against Chinese monetary excesses gains plausibility from a reported credit market ramp-up from $1 trillion in 2000 to $25 trillion today. He concludes, “This heedless resort to the printing press” has left China with a “freakish economy” comprising “one great collection of impossibilities that cannot be . . . propped up much longer. . . . It is only a matter of time before it ends in a spectacular collapse, leaving the global financial bubble of the last two decades in shambles.”
The argument that China’s monetary policy now threatens the entire world economy—“it is only a matter of time”—depends on a particular view of the nature and role of money. To what degree do monetary factors determine business and technological realities? That is a question that has perplexed me for decades.
My guide on the subject has long been Robert Mundell. With Arthur Laffer and Milton Friedman, Mundell shaped the Reagan revolution in economics. Believing that reliable monetary values were a necessary complement to low tax rates in enabling economic growth, Mundell was an enthusiast for the monetary stability achieved under the Bretton Woods system. Named after the New Hampshire resort where the agreement was negotiated in 1944, toward the end of World War II, Bretton Woods ushered in twenty-five years of global economic growth of 2.8 percent per year, unequalled before or since.
The golden age of Bretton Woods ended in 1971, when for the first time in more than two centuries most of the world’s economies, including the United States, cut all ties to gold. Counseling President Nixon on this historic decision was Milton Friedman, who believed that currencies should float against one another as they do today.
During my trip to China with Friedman in 1988, my own advice for the communists skipped money altogether and focused on freedom. Recalling Mao’s duplicitous appeal to Chinese intellectuals “to let a hundred flowers bloom,” I told them, “This statement showed [Mao’s] incomparable misunderstanding of the powers of the Chinese people.” I called for an efflorescence of entrepreneurship: “Let a billion flowers bloom.”2
When asked what would happen in 1997, when Great Britain was to transfer control of Hong Kong to the People’s Republic of China, I said, “1997 is the year that Hong Kong will begin to take over China.” At the time, I had no real sense of how this would happen. But the mayor of Shanghai and later PRC president, Jiang Zemin, and Premier Deng Xiaoping led a movement to duplicate the success of Hong Kong in “free zones” all along the coast of China. Beginning with Jiang’s Shanghai, these free zones, modeled on Hong Kong, produced what we all know now as the “Chinese miracle.”
Conceived by Deng and Jiang, the free-zone strategy contrasts with the largely failed one-zone approach of the Soviet Union. The effort to emancipate the USSR from the center out maximized resistance, provoking bitter last-ditch opposition from all who benefited from the old system. The incentives of the free-zone strategy, by contrast, were just the opposite. Everyone outside the zone wanted to get in. The pressure was on to expand the zones. Jiang also put key military bases in the free zones, thus enlisting sectors of the Chinese People’s Liberation Army in the economic liberation movement.
Hardly a Ponzi scheme, this strategy was perhaps the single most successful freedom movement in world history. Yet Jiang Zemin, its leading protagonist along with Deng, was a complex man, presenting his own Rorschach test to historians. Known as an authoritarian, he assumed the presidency after the Tiananmen Square protests and initiated the crackdown on the Falun Gong. An electrical engineer who befriended leading figures in the U.S. semiconductor industry, Jiang spoke several foreign languages and was known to recite the Gettysburg Address by heart. A passionate supporter of economic progress, he correctly saw that inequality was necessary if China was ever to develop.
People who have known Jiang regard him as a great figure in the history of our era, a politician who managed to survive and achieve historic change in the teeth of the treacherous environment of the Chinese communist regime despite his intense admiration for America, its technology and economics. Although Jiang is not Christian himself, his son Jiang Mianheng conditioned his launch of a microchip foundry in Shanghai, called Grace Semiconductor, on the willingness of local authorities to allow a Christian church to be built on the premises.
Back in 1988 I anticipated none of this. But I said that a Chinese revival of freedom would make China the world’s largest economy by 2015, the year in which I am now writing. By measures of purchasing power parity (PPP), this prediction has come true.3
So what does this success have to do with monetary policy? China’s success is a major empirical rebuke to Friedman’s monetarism. China never adopted Friedman’s monetarism or belief in floating currencies. Instead, it fixed the value of the yuan on the dollar, much to the chagrin of American monetarists, and adopted as its favorite economist Milton Friedman’s intellectual foe and fellow Nobel laureate Robert Mundell. A supply-sider and admirer of the gold standard, Mundell believes in fixed currencies. The Chinese named their leading financial university in Beijing the Mundell International University of Entrepreneurship, and thirty universities in China have named him an honorary professor.
As Mundell predicted decades ago, state control of money has become a cornerstone of government economic centralization. Adopted by most of the world, Friedman’s float has become an oceanic global market with a trading volume of some $5.3 trillion every twenty-four hours, dwarfing all markets for goods and services.4 Yet floating currencies have not tamed financial crises or enhanced world trade or eased political conflict. No one can show that they approach real values, since their massive gyrations—the yen-dollar rate, for example, changed for decades at an average rate of around 4 percent a month—do not reflect any substantial change in comparative purchasing power or any other measure of competitiveness.
As Mundell writes, “Friedman was wrong when he predicted that under flexible exchange rates countries would not need reserves. Countries need more reserves today . . . than they ever needed under fixed exchange rates” with Bretton Woods or the gold standard. Mundell predicts that, along with the dollar, the “stock of gold in the world is going to maintain itself as a viable reserve asset for a long time to come.” Despite Mundell’s critique, government-controlled money is more entrenched than ever, but with the help of China and other emerging economies, Mundell and the believers in fixed or pegged currencies may well prevail in the future.
Money can reside outside the political system, perhaps in digital forms on the Internet, perhaps with a new link to gold. It does not need central bank management. The energy and effort diverted into trading more than $5 trillion every twenty-four hours to “mint” a global paper currency could be directed instead in productive enterprises.
In a world where capital can flow freely because it is expressed in one metric, trade does not have to balance. Capital and trade are complementary factors. When one goes up, the other goes down. Capital is more mobile and flexible than goods and services, and its movements can drive trade movements. A Chinese company has to choose whether to use its dollars to buy a good or whether to invest them in the United States. Today, many Chinese avidly want a stake in America, drawn by its technologies and its constitutional rule of law. Investments across borders thus can shape the trade balance (rather than the other way around, as most economists assume).
Gold is now ascendant not only in China but in many parts of Asia, which has become the new spearhead of world economic growth and capitalism, with tax rates widely running between one-half and one-third of those in the West.5 China in 2014 was importing a record $70 billion worth of physical gold, passing newly capitalist India as the world’s leading gold importer and implicitly relying on gold as monetary ballast for its floundering banks.6
To the chagrin of conventional economists in the United States, China has mostly opted out of the floating-currency regime and effectively tied its currency to the dollar. For refusing to float and defending the dollar against Washington’s devaluers, China has been rewarded with a huge increase in trade with the United States. It is for muting currency changes and supporting the dollar that China incurs continual charges of “currency manipulation” from American politicians and government officials who advocate constant currency manipulation by the Federal Reserve.
Nonetheless, while attempting to appease a long list of utterly unappeasable foes—Iran, North Korea, Hamas, Hezbollah, Cuba, and even the fractious followers of Hugo Chávez—the United States all too often treats China, perhaps our most important economic partner, as an adversary because it defies us on global warming, dollar devaluation, and Internet policy.
The browbeating began in June 2010 in Beijing when Treasury Secretary Timothy Geithner drilled in on Premier Wen Jiabao, who recoiled like a man cornered by a crank at a cocktail party. Mr. Geithner’s harangue was focused on two highly questionable concerns, neither arguably in the interests of either country: the need to suppress energy output for the sake of the global climate—a subject on which Mr. Geithner has no expertise—and the need for a Chinese dollar devaluation against the yuan, of which one can scarcely imagine that he can persuade Chinese holders of several trillion dollars of reserves. Five years later, China finally did allow market forces to influence its currency. The result was its depreciation against the dollar, utterly contrary to American complaints during that time.
Our case against China with respect to the Internet is also overwrought. Although commanding twice as many Internet users as we do and, with Taiwan, producing comparable amounts of Internet gear, China originates fewer viruses and scams than does the United States. An authoritarian regime, China obviously will not be amenable to an open and anonymous Internet. Protecting information on the Internet is a responsibility of U.S. corporations and their security tools, not the State Department.
Yes, the Chinese at times seem needlessly aggressive in deploying missiles aimed at Taiwan and in their claims of territorial waters in the Pacific. But there is no prospect of successful U.S. military action in that region, and sending Taiwan new weapons is a needless provocation that does not contribute to the defense of the United States or Taiwan.
A serious foreign policy would recognize that the current Chinese regime is the best we can expect from that country. The Chinese revitalization of Asian capitalism remains the most important positive event in the world in the last thirty years, releasing a billion people from penury and oppression and transforming China from a communist enemy of the United States into an indispensable capitalist partner. It is ironic that liberals who once welcomed appeasement of the monstrous regime of Mao Zedong now become openly bellicose over murky incidents of Internet hacking.
With millions of Islamists on its borders and within them, China is nearly as threatened by radical Islam as we are. It has a huge stake in the global capitalist economy that Islamic terrorists aim to overthrow, and China is so heavily dependent on Taiwanese manufacturing and so intertwined with Taiwan’s industry that its military threat to the island is mostly theater. Although some Taiwanese politicians still dream of permanent independence, the island’s world-beating entrepreneurs have long since laid their bets on links to the mainland. Two-thirds of Taiwanese companies—some ten thousand—have made significant investments in China over the last decade, totaling $400 billion. Three-quarters of a million Taiwanese reside in China for more than 180 days a year.
Including Taiwan, greater China is the world’s leading manufacturer and assembler of microchips, computers, and the network equipment on which the Internet subsists. Virtually all U.S. advanced electronics, as the eminent chemist Arthur Robinson has reported in his newsletter Access to Energy, are dependent on rare earth elements to enhance the performance of microchips, elements that are held in a near-global monopoly by the Chinese firm Baotou Steel Rare-Earth Hi-Tech Company in Mongolia.
The United States is as dependent on China for its economic and military health as China is dependent on the United States for its key markets, reserve finance, and global capitalist trading regime. It would be self-destructive folly to sacrifice the synergy at the heart of global capitalism in order to gain concessions on global warming, dollar weakening, or Internet politics. How many enemies do we need?
To David Stockman, none of this matters much, because China is a paper tiger: “The 25 year growth boom in China is just a giant, credit driven Ponzi.” As he sums it up, “Any fool can run a central bank printing press until it glows white hot.”7
Stockman’s idea of “any fool” is Zhou Xiaochuan, since 2002 the chairman of the People’s Bank of China and manager of their monetary policy. Stockman imagines that Wall Street sees Zhou “as an Asian version of Janet Yellen who wears trousers and dyes his hair black.” Although Stockman is an inspired critic of Wall Street and the Fed, he seems to have no inkling of the achievements of Zhou and his team.
With advanced degrees in both chemistry and computer science, Zhou was a key part of Jiang Zemin’s free-zone strategy in Shanghai that was the heart of the Chinese miracle. In recent decades, Zhou has become a sophisticated monetary theorist and trenchant critic of the floating-currency regime supported in the West. The author of scores of papers and monographs on monetary policy, he delivered a visionary address on March 24, 2009, calling for an end to freely floating currencies and a revival of Keynes’s “bancor” proposal made at Bretton Woods in 1944. Tied to gold, bancor would serve as a single measuring stick used to value all transactions in international commerce and gauge all international flows of goods and capital.
Largely under Zhou’s economic leadership, China’s private sector outstripped its stagnant state-run enterprises to such an extent that government spending has now dropped to under 17 percent of GDP, compared with 26 percent in the United States. The Chinese have even privatized their post office. Meanwhile, the United States has been expanding state controls over public companies under the costly and destructive Sarbanes-Oxley accounting rules, fair disclosure speech controls, and other self-defeating regulations, gravely impairing its initial public offering (IPO) market. IPOs have long served as the heart of America’s entrepreneurial economy and the NASDAQ exchange. Jiang Zemin called it “the crown jewel of all that is great about America.” Under Jiang’s disciple Zhou, China has been emancipating its stock exchanges and connecting its new NASDAQ counterpart in free-zone Shenzhen to the long-thriving Hong Kong exchange. In 2015 China easily surpassed the United States in IPOs. In the first half of 2015, China had 221 IPOs, worth $39 billion. There were fewer than half that number in the United States, ninety-six, valued at $19.68 billion. In quality, moreover, the Chinese IPOs were more formidable in many ways than the American froth of Internet and gaming stocks.
The Chinese lead in IPOs portends an eventual challenge in venture capital. China has recently passed Europe in deal count and tripled Europe in venture funds raised. China lags the U.S. venture industry by about 45 percent in money and deal count, but much of Silicon Valley’s investment has gone to some eighty “unicorns,” with valuations over a billion dollars, which have shunned the overregulated U.S. public market. This is a bizarre and unsustainable situation. Venture capital cannot function without liquidity events. Unless the United States follows China and begins to deregulate its public companies, China will soon take the lead in venture capital as well.
The innovative venture capital culture of Silicon Valley, capped by IPOs, has long been the prime source of growth in the U.S. economy, providing 21 percent of GDP, 17 percent of jobs, and perhaps 60 percent of stock market capitalization. The current regulatory regime, from the Securities and Exchange Commission (SEC) to the Food and Drug Administration to the Environmental Protection Agency, is stifling this engine of American growth and power. With China now reporting lower government spending than the United States, along with potential leadership in venture capital and IPOs, Americans are foolhardy to imagine that China will long remain behind.
China remains a complex challenge because it is a combination of wildly disparate elements. In evolutionary terms, below a mostly modern technocratic capitalism it harbors a kind of vestigial reptilian brain, represented by its ruling military and party apparatchiks. Among them are the “bunch of communist party hacks” that in Stockman’s caricature “have an iron grip on state power . . . but [no] grasp of the fundamentals of economic law and sound finance.” They do control vast regions of the country, but they do not dominate the rapidly emerging Chinese culture of enterprise, which for all its flaws and excesses is rapidly moving toward ascendancy in the world economy.
China’s economic achievement, which has moved more people out of poverty than any country has ever done, proves that Jiang was right. Economic progress can definitely precede political democratization. Since 1982, when Deng Xiaoping declared that “to get rich is glorious,” China’s city dwellers have increased their incomes fourteenfold.8 Now the challenge is to show that a communist regime can use capitalist freedoms to expand democracy and civil liberty, which should be the next step for Jiang’s free-zone strategy. But our next step should be to address China’s critique of our own manipulative monetary policy.
A key reason why China has led the world in growth for twenty-five years has been its rejection of American monetary advice. Following Mundell’s inspiration, it has mostly forgone the monetary twists and tricks concocted by other Western economists and instead fixed its currency on the dollar.
As Zhou would readily acknowledge, this is not the optimal solution. But with both Reagan and Clinton following a “strong dollar policy,” this Chinese fix made U.S.-China trade the pivot of world economic growth and progress. Following Mundell’s guidance, China has trumped America’s long embrace of an obsolete monetarism. China has reined in its central bank, but America has paid dearly for clinging to the monetarist delusion.